Thinking Points

  • Japan Foundation Engineering (TSE: 1914) is a construction company specializing in large-scale foundation work, historically generating over 70% of its revenues from public projects.
  • More recently, the company has increasingly worked on private projects, which accounted for 37.6% of revenues during fiscal 2018.
  • The company’s lagging operating performance amid a healthy construction environment is largely due to its US operations, which has consistently generated losses since 2009 except for one year in 2016.
  • At 365 yen per share, JFE trades at 81.6% of adjusted NCAV with a market capitalization of 9,820 million yen ($90.8 million USD).
  • Investors can expect an investment CAGR of between 0% and 17.3%, inclusive of dividends, over the next 5 to 8 years, with the key driving factor being JFE’s ability to execute in the US.

Introduction

Japan Foundation Engineering (JFE, TSE: 1914) is a construction company specializing in large-scale foundation work. The company is a single segment operation, but provides a breakdown of revenues by project type:

Source: Company filings

As of this writing, the 2019 short form filings, which do not contain a breakdown of revenues, are released. Hence, the above breakdown is from the 2018 long form filings. A quick look at historical financials shows the company has frequently generated losses. However, there are reasons investors may want to look at this as a positive sign.

The business & environment

Japan Foundation Engineering was originally founded in 1935, but suspended operations not long after its founding. The current form of the company came about in 1953, when it merged with Nippon Grout Industries. Based out of Osaka, JFE mainly worked on boring and grouting projects for tunnels, dams, reclamation lands, and reservoirs.

Due to the nature of its projects, JFE is largely dependent on healthy government spending. Historically, over 70% of company revenues came from government projects. More recently, however, JFE’s private sector projects have accounted for over 30% of company revenues. In 2018, the company generated 62.4% of revenues from public projects and 37.6% of revenues from private projects.

Source: Company filings

Still, JFE is highly dependent on government spending. After a two decade decline, the construction investment environment started to improve in 2011.

Source: Japan Federation of Construction Contractors (Japanese), translation by Kenkyo Investing

While the company’s revenue performance has improved since, its operating performance leaves room for improvement:

Source: Company filings

In its 2018 long form filings, JFE noted that 91.2% of its revenues were generated as a subcontractor, pointing out its exposure to general contractors. Based on shareholdings, the two key general contractors to pay close attention to are Taisei Construction (TSE: 1801) and Hazama Ando Corp (TSE: 1719).

Given Hazama Ando Corp’s historical strength in dam construction and the recent decline in JFE’s dam foundation revenues, a domestic dam project award to Hazama Ando may materially increase JFE’s top-line.

Source: Company filings

The key reason behind JFE’s lagging operating performance, however, is its US operations. The company JAFEC USA in 2009, but profitability has been an issue. JAFEC USA briefly turned a profit in 2016, but has been generating losses for all of the other years in operation.

In 2015, JAFEC USA was sued by an American power company (Japanese) for accidentally destroying a high voltage power line at the project site. While the company’s insurance covered the 2.8 million USD settlement, it’s clear that JFE’s execution in the US has been difficult to say the least.

The good news here is that JFE’s domestic business is generally healthy and the company is making efforts to expand its business overseas. While the company does not disclose the financials for JAFEC USA, its US operation reaching a consistent break-even point would likely improve overall operating performance dramatically.

In its medium term plan, which covers fiscal years 2018 through 2020, JFE set a revenue target of 22,500 million yen ($208 million USD) and operating income target of 450 million yen ($4.2 million USD). As of fiscal 2019, the company has already achieved these targets, generating 24,481 million yen ($226 million USD) in revenues and 468 million yen ($4.3 million USD) in operating income.

For 2020, JFE kept its guidance in-line with the medium term plan with revenues of 22,500 million yen ($208 million USD) and operating income of 450 million yen ($4.2 million USD).

Shareholders

As of Q4 2019 (ending March 31st, 2019), JFE had 30,846,400 shares issued and 3,943,499 shares in treasury, putting outstanding shares at 26,902,901.

Here are the major shareholders:

Source: Company filings

The company has no controlling shareholder and no management equity compensation plans.

After years of no share repurchases, JFE repurchased shares in fiscal 2016, then again in 2018. This effort appears to continue into fiscal 2019 in form, with the board announcing a repurchase (Japanese) of 120,000 shares (0.4% of outstanding) for 48 million yen ($445K USD), or 400 yen per share.

Financials & Valuation

  • Japan Foundation Engineering is a construction company specializing in large-scale foundation work, historically generating over 70% of its revenues from public projects.
  • More recently, the company has increasingly worked on private projects, which accounted for 37.6% of revenues during fiscal 2018.
  • The company’s lagging operating performance amid a healthy construction environment is largely due to its US operations, which has consistently generated losses since 2009 except for one year in 2016.
  • At 365 yen per share, JFE trades at 81.6% of adjusted NCAV with a market capitalization of 9,820 million yen ($90.8 million USD).
  • Investors can expect an investment CAGR of between 0% and 17.3%, inclusive of dividends, over the next 5 to 8 years, with the key driving factor being JFE’s ability to execute in the US.

Japan Foundation Engineering is a construction company specializing in foundation work. The company is particularly known for dam foundation, grouting, and slope protection works. Although JFE has historically relied on public projects, the company has increasingly taken on private projects over the last decade. In 2018, private projects accounted for 37.6% of annual revenues compared to a historical public/private split of 70:30.

While the Japanese construction industry has been generally healthy over the last five years, JFE’s business performance has lagged. Over the last 13 years, the company has generated operating losses in 5 years, with operating margins never exceeding 6%. Much of this is due to the company’s struggling US operations.

JFE expanded into the US in 2009 by setting up JAFEC USA. The company reached profitability for a single year in 2016, then went back to generating losses. In its historical filings, JFE regularly comments about the US operations being a key driver for low overall profitability.

The good news here is that JFE’s domestic business remains in generally good health. Moreover, the company is taking the leap to expand foreign operations. Depending on JFE’s ability to execute, a profitable US operations may considerably improve overall business performance.

JFE is well capitalized, with no debt and an equity to asset ratio of 0.74. Although the company has land holdings in major cities across Japan, it took advantage of a temporary law permitting revaluation of land values in 2002, resulting in the book value of company land better reflecting market prices.

At 365 yen per share, JFE trades at an unadjusted 138% of NCAV with a market capitalization of 9,820 million yen ($90.8 million USD). Adjusted for long term investment security holdings, however, the company trades at 81.6% NCAV.

The major risk for JFE is continued loss generation in its US operations. Over the last two fiscal years, the company noted improved business performance in the form of reduced losses, but there is no way to tell whether the US operation has stabilized yet. Assuming it has not, it’s fair to say JFE’s current valuation is fair.

If we assume JFE is able to get its US operation to profitability in the next couple of years, the company will likely generate a higher-than-normalized level of profit. In this case, fair value would likely be above 120% adjusted NCAV.

With the two investment cases in mind, investors can expect an investment CAGR of between 0% and 17.3%, inclusive of dividends, over the next 5 to 8 years, with the key driving factor being JFE’s ability to execute in the US.

The bottom line

Japan Foundation Engineering is a construction company specializing in large-scale foundation work. Its domestic business has been generally healthy, however, the company has been unable to get its US operations to consistent profitability. Investors can expect an investment CAGR of between 0% and 17.3%, inclusive of dividends, over the next 5 to 8 years, with the key driver being whether or not JFE can execute successfully in the US.


Kenkyo Investing
Kenkyo Investing

Kenkyo Investing applies a value investing approach to Japanese equities, providing insights that are often unavailable to non-Japanese speakers.